[Script Info]
Title: 
[Events]
Format: Layer, Start, End, Style, Name, MarginL, MarginR, MarginV, Effect, Text
Dialogue: 0,0:00:00.84,0:00:05.42,Default,,0000,0000,0000,,I figure now is as good a time\Nas any to learn about probably
Dialogue: 0,0:00:05.42,0:00:08.42,Default,,0000,0000,0000,,what most people focus the\Nmost on when they analyze
Dialogue: 0,0:00:08.42,0:00:10.19,Default,,0000,0000,0000,,companies, and that's the\Nincome statement.
Dialogue: 0,0:00:10.19,0:00:13.60,Default,,0000,0000,0000,,And the income statement is\None of the three financial
Dialogue: 0,0:00:13.60,0:00:15.62,Default,,0000,0000,0000,,statements that you'll look at\Nwhen you look at a company.
Dialogue: 0,0:00:15.62,0:00:17.36,Default,,0000,0000,0000,,There's the income statement\Nand the other two are the
Dialogue: 0,0:00:17.36,0:00:21.56,Default,,0000,0000,0000,,balance sheet, which I have\Ndrawn a lot in a lot of the
Dialogue: 0,0:00:21.56,0:00:23.76,Default,,0000,0000,0000,,other explanations I've done\Non the financial crisis and
Dialogue: 0,0:00:23.76,0:00:24.33,Default,,0000,0000,0000,,whatever else.
Dialogue: 0,0:00:24.33,0:00:25.64,Default,,0000,0000,0000,,And actually, in this video,\Nwe're going to see how the
Dialogue: 0,0:00:25.64,0:00:27.75,Default,,0000,0000,0000,,income statement relates\Nto the balance sheet.
Dialogue: 0,0:00:27.75,0:00:29.67,Default,,0000,0000,0000,,And, of course, the last one--\Nwell, it's not of course if
Dialogue: 0,0:00:29.67,0:00:31.02,Default,,0000,0000,0000,,you don't know it-- is the\Ncash flow statement.
Dialogue: 0,0:00:35.48,0:00:38.19,Default,,0000,0000,0000,,And we'll focus on that a\Nlittle bit later because
Dialogue: 0,0:00:38.19,0:00:40.08,Default,,0000,0000,0000,,that's a little bit more\Nnuanced relative
Dialogue: 0,0:00:40.08,0:00:41.73,Default,,0000,0000,0000,,to the income statement.
Dialogue: 0,0:00:41.73,0:00:44.57,Default,,0000,0000,0000,,So the income statement is\Nliterally just saying how much
Dialogue: 0,0:00:44.57,0:00:47.92,Default,,0000,0000,0000,,a company might earn in a given\Nperiod, and it's always
Dialogue: 0,0:00:47.92,0:00:48.92,Default,,0000,0000,0000,,related to a period.
Dialogue: 0,0:00:48.92,0:00:51.89,Default,,0000,0000,0000,,So it could be an annual\Nincome statement.
Dialogue: 0,0:00:51.89,0:00:53.79,Default,,0000,0000,0000,,It could be for the year 2008.
Dialogue: 0,0:00:53.79,0:00:55.48,Default,,0000,0000,0000,,It could be a quarterly\Nincome statement.
Dialogue: 0,0:00:55.48,0:00:56.97,Default,,0000,0000,0000,,Those are usually the two\Ntypes that you see, but
Dialogue: 0,0:00:56.97,0:01:01.39,Default,,0000,0000,0000,,sometimes, there's monthly or\Nsix-month income statements.
Dialogue: 0,0:01:01.39,0:01:05.08,Default,,0000,0000,0000,,And the general format is pretty\Nconsistent, although
Dialogue: 0,0:01:05.08,0:01:07.41,Default,,0000,0000,0000,,there is a lot of variation\Ndepending on what a business
Dialogue: 0,0:01:07.41,0:01:10.32,Default,,0000,0000,0000,,does, but in this video, I\Nreally just want to cover
Dialogue: 0,0:01:10.32,0:01:13.02,Default,,0000,0000,0000,,almost a plain vanilla income\Nstatement for a company that
Dialogue: 0,0:01:13.02,0:01:14.68,Default,,0000,0000,0000,,just sells a widget.
Dialogue: 0,0:01:14.68,0:01:17.98,Default,,0000,0000,0000,,So the first thing when you sell\Na widget is you make it
Dialogue: 0,0:01:17.98,0:01:19.44,Default,,0000,0000,0000,,and you just sell it.
Dialogue: 0,0:01:19.44,0:01:20.29,Default,,0000,0000,0000,,You sell the widget.
Dialogue: 0,0:01:20.29,0:01:25.63,Default,,0000,0000,0000,,You give a customer a widget,\Nand they give you some money.
Dialogue: 0,0:01:25.63,0:01:28.31,Default,,0000,0000,0000,,And that money that they give\Nyou-- and I'm not going to get
Dialogue: 0,0:01:28.31,0:01:30.04,Default,,0000,0000,0000,,too technical about the\Naccounting right now-- is
Dialogue: 0,0:01:30.04,0:01:31.29,Default,,0000,0000,0000,,considered revenue.
Dialogue: 0,0:01:34.36,0:01:39.08,Default,,0000,0000,0000,,It's sometimes considered\Nsales.
Dialogue: 0,0:01:39.08,0:01:41.59,Default,,0000,0000,0000,,And that's literally the money\Nthat they give you at a
Dialogue: 0,0:01:41.59,0:01:42.62,Default,,0000,0000,0000,,certain period of time.
Dialogue: 0,0:01:42.62,0:01:44.76,Default,,0000,0000,0000,,And some of you accountants out\Nthere are like, oh, well,
Dialogue: 0,0:01:44.76,0:01:46.45,Default,,0000,0000,0000,,no, that's not just the money\Nthat they give you.
Dialogue: 0,0:01:46.45,0:01:48.68,Default,,0000,0000,0000,,It's the money that you've\Nearned in a certain period of
Dialogue: 0,0:01:48.68,0:01:49.71,Default,,0000,0000,0000,,time, and that's true.
Dialogue: 0,0:01:49.71,0:01:53.79,Default,,0000,0000,0000,,But for our sake, let's just\Nsay that when you give the
Dialogue: 0,0:01:53.79,0:01:56.41,Default,,0000,0000,0000,,widget, you have earned the\Nmoney that they give you, and
Dialogue: 0,0:01:56.41,0:01:57.46,Default,,0000,0000,0000,,that's revenue sales.
Dialogue: 0,0:01:57.46,0:01:59.75,Default,,0000,0000,0000,,Later on, we'll talk about\Ndifferent ways to account
Dialogue: 0,0:01:59.75,0:02:01.20,Default,,0000,0000,0000,,revenue and sales.
Dialogue: 0,0:02:01.20,0:02:03.62,Default,,0000,0000,0000,,So let's say the revenue or the\Nsales in this case in a
Dialogue: 0,0:02:03.62,0:02:05.06,Default,,0000,0000,0000,,given period, let's say\Nthat this is an income
Dialogue: 0,0:02:05.06,0:02:07.70,Default,,0000,0000,0000,,statement for 2008.
Dialogue: 0,0:02:07.70,0:02:13.05,Default,,0000,0000,0000,,So over 2008, we sold\Nlet's say $3
Dialogue: 0,0:02:13.05,0:02:14.57,Default,,0000,0000,0000,,million worth of widgets.
Dialogue: 0,0:02:19.18,0:02:24.34,Default,,0000,0000,0000,,So let's say it's $3 million.
Dialogue: 0,0:02:24.34,0:02:26.97,Default,,0000,0000,0000,,And a lot of times when you look\Nat income statements for
Dialogue: 0,0:02:26.97,0:02:28.04,Default,,0000,0000,0000,,companies, if you go to Yahoo!
Dialogue: 0,0:02:28.04,0:02:30.31,Default,,0000,0000,0000,,Finance, you could do this right\Nnow, instead of writing
Dialogue: 0,0:02:30.31,0:02:32.52,Default,,0000,0000,0000,,$3 million, you'll\Nsee $3,000 there.
Dialogue: 0,0:02:32.52,0:02:33.16,Default,,0000,0000,0000,,It's like, oh, my God!
Dialogue: 0,0:02:33.16,0:02:35.44,Default,,0000,0000,0000,,This company, they're hardly\Nselling anything.
Dialogue: 0,0:02:35.44,0:02:39.25,Default,,0000,0000,0000,,But it's kind of a standard that\Nthey tend to write things
Dialogue: 0,0:02:39.25,0:02:40.05,Default,,0000,0000,0000,,in thousands.
Dialogue: 0,0:02:40.05,0:02:42.95,Default,,0000,0000,0000,,So 3,000 would be\N3,000 thousands,
Dialogue: 0,0:02:42.95,0:02:44.00,Default,,0000,0000,0000,,which would be 3 million.
Dialogue: 0,0:02:44.00,0:02:46.06,Default,,0000,0000,0000,,And for really big companies,\Nthey actually sometimes write
Dialogue: 0,0:02:46.06,0:02:47.33,Default,,0000,0000,0000,,their numbers in millions.
Dialogue: 0,0:02:47.33,0:02:50.53,Default,,0000,0000,0000,,So if you saw 3,000 there, it\Nwould actually mean 3 billion.
Dialogue: 0,0:02:50.53,0:02:53.19,Default,,0000,0000,0000,,But we'll actually look at real\Nincome statements in the
Dialogue: 0,0:02:53.19,0:02:54.31,Default,,0000,0000,0000,,not-too-far-off future.
Dialogue: 0,0:02:54.31,0:02:57.77,Default,,0000,0000,0000,,So that's how much money\Nthey give us.
Dialogue: 0,0:02:57.77,0:03:01.91,Default,,0000,0000,0000,,But that's not how much income\Nwe made, because there was a
Dialogue: 0,0:03:01.91,0:03:04.75,Default,,0000,0000,0000,,lot of cost that went into\Nmaking that widget that we
Dialogue: 0,0:03:04.75,0:03:05.28,Default,,0000,0000,0000,,have to account for.
Dialogue: 0,0:03:05.28,0:03:07.71,Default,,0000,0000,0000,,It's not like when someone gives\Nme $3 million, I can
Dialogue: 0,0:03:07.71,0:03:09.10,Default,,0000,0000,0000,,just say, oh, I made\N$3 million.
Dialogue: 0,0:03:09.10,0:03:10.46,Default,,0000,0000,0000,,Let me just put it\Nall in the bank.
Dialogue: 0,0:03:10.46,0:03:11.04,Default,,0000,0000,0000,,I'm done.
Dialogue: 0,0:03:11.04,0:03:12.98,Default,,0000,0000,0000,,That was all income.
Dialogue: 0,0:03:12.98,0:03:15.72,Default,,0000,0000,0000,,So the first thing that you\Ntend to see on an income
Dialogue: 0,0:03:15.72,0:03:18.93,Default,,0000,0000,0000,,statement is the cost of those\Nactual widgets, the cost of
Dialogue: 0,0:03:18.93,0:03:21.51,Default,,0000,0000,0000,,producing those widgets.
Dialogue: 0,0:03:21.51,0:03:25.55,Default,,0000,0000,0000,,And I'll put all my expenses\Nin magenta.
Dialogue: 0,0:03:25.55,0:03:30.87,Default,,0000,0000,0000,,So it'll sometimes be written\Nas cost of sales or cost of
Dialogue: 0,0:03:30.87,0:03:32.12,Default,,0000,0000,0000,,goods sold.
Dialogue: 0,0:03:35.44,0:03:37.57,Default,,0000,0000,0000,,And this is literally-- well,\Nthere's two things.
Dialogue: 0,0:03:37.57,0:03:41.19,Default,,0000,0000,0000,,There's a variable cost which\Nis, each widget, they might
Dialogue: 0,0:03:41.19,0:03:44.80,Default,,0000,0000,0000,,have used some amount of metal\Nand some amount of energy to
Dialogue: 0,0:03:44.80,0:03:47.54,Default,,0000,0000,0000,,produce it and some\Namount of paint if
Dialogue: 0,0:03:47.54,0:03:48.96,Default,,0000,0000,0000,,it's a painted widget.
Dialogue: 0,0:03:48.96,0:03:51.49,Default,,0000,0000,0000,,And so that the cost of goods\Nis literally how much did it
Dialogue: 0,0:03:51.49,0:03:54.68,Default,,0000,0000,0000,,cost to buy the metal and the\Npaint and provide the
Dialogue: 0,0:03:54.68,0:03:59.00,Default,,0000,0000,0000,,electricity to make those $3\Nmillion worth of widgets.
Dialogue: 0,0:03:59.00,0:04:00.82,Default,,0000,0000,0000,,That's the variable cost. And\Nthen on top of that you have
Dialogue: 0,0:04:00.82,0:04:03.50,Default,,0000,0000,0000,,the fixed costs, or the\Nrelatively fixed costs, where
Dialogue: 0,0:04:03.50,0:04:07.28,Default,,0000,0000,0000,,just to have the factory open,\Nit costs a certain amount of
Dialogue: 0,0:04:07.28,0:04:09.96,Default,,0000,0000,0000,,money every year, regardless of\Nhow many widgets you make.
Dialogue: 0,0:04:09.96,0:04:11.96,Default,,0000,0000,0000,,And we'll go into more detail\Non that, But for simplicity,
Dialogue: 0,0:04:11.96,0:04:14.07,Default,,0000,0000,0000,,let's say all those costs\Nof making the
Dialogue: 0,0:04:14.07,0:04:17.73,Default,,0000,0000,0000,,widgets were $1 million.
Dialogue: 0,0:04:17.73,0:04:21.22,Default,,0000,0000,0000,,So sometimes someone might say\Nit's a $1 million cost. When I
Dialogue: 0,0:04:21.22,0:04:23.87,Default,,0000,0000,0000,,make models, I like to put\Na minus there, so that I
Dialogue: 0,0:04:23.87,0:04:28.37,Default,,0000,0000,0000,,remember that that's a cost.\NAnything that detracts from
Dialogue: 0,0:04:28.37,0:04:29.55,Default,,0000,0000,0000,,income I put as a minus.
Dialogue: 0,0:04:29.55,0:04:31.76,Default,,0000,0000,0000,,Anything that adds is a plus,\Nalthough that's not
Dialogue: 0,0:04:31.76,0:04:33.43,Default,,0000,0000,0000,,necessarily the standard\Nconvention.
Dialogue: 0,0:04:33.43,0:04:36.82,Default,,0000,0000,0000,,Some people say, oh, it's a\Npositive $1 million cost,
Dialogue: 0,0:04:36.82,0:04:37.92,Default,,0000,0000,0000,,which means you subtract.
Dialogue: 0,0:04:37.92,0:04:40.73,Default,,0000,0000,0000,,But either way I think\Nyou get the point.
Dialogue: 0,0:04:40.73,0:04:46.43,Default,,0000,0000,0000,,And then if you subtract your\Ncosts from your revenue, or if
Dialogue: 0,0:04:46.43,0:04:48.28,Default,,0000,0000,0000,,you just add these two numbers,\Nbecause this one is
Dialogue: 0,0:04:48.28,0:04:50.49,Default,,0000,0000,0000,,negative, you have your\Ngross profit.
Dialogue: 0,0:04:58.98,0:05:00.90,Default,,0000,0000,0000,,And in this case, it would\Nbe $2 million.
Dialogue: 0,0:05:05.03,0:05:10.26,Default,,0000,0000,0000,,And this number tells you, how\Nmuch money did you make, or
Dialogue: 0,0:05:10.26,0:05:12.35,Default,,0000,0000,0000,,how much profit did\Nyou make just from
Dialogue: 0,0:05:12.35,0:05:13.68,Default,,0000,0000,0000,,selling these widgets?
Dialogue: 0,0:05:13.68,0:05:18.53,Default,,0000,0000,0000,,So the more widgets you sell,\Nin most circumstances, the
Dialogue: 0,0:05:18.53,0:05:21.56,Default,,0000,0000,0000,,larger this number\Nis going to be.
Dialogue: 0,0:05:21.56,0:05:26.72,Default,,0000,0000,0000,,So this is your profit before\Nall of the other expenses that
Dialogue: 0,0:05:26.72,0:05:29.29,Default,,0000,0000,0000,,a company has to incur,\Nlike the taxes
Dialogue: 0,0:05:29.29,0:05:30.73,Default,,0000,0000,0000,,and the CEO's salary.
Dialogue: 0,0:05:30.73,0:05:32.61,Default,,0000,0000,0000,,The CEO's salary doesn't\Ngo in here, right?
Dialogue: 0,0:05:32.61,0:05:38.89,Default,,0000,0000,0000,,Because the CEO doesn't go out\Nthere to the factory in most
Dialogue: 0,0:05:38.89,0:05:40.48,Default,,0000,0000,0000,,cases and actually help\Nmake the widget.
Dialogue: 0,0:05:40.48,0:05:43.61,Default,,0000,0000,0000,,So the CEO's salary or the\NCFO's salary or the
Dialogue: 0,0:05:43.61,0:05:46.16,Default,,0000,0000,0000,,headquarters in a nice\Nskyscraper, that doesn't get
Dialogue: 0,0:05:46.16,0:05:47.14,Default,,0000,0000,0000,,factored in here.
Dialogue: 0,0:05:47.14,0:05:48.62,Default,,0000,0000,0000,,Or the marketing\Nexpense, right?
Dialogue: 0,0:05:48.62,0:05:50.49,Default,,0000,0000,0000,,You have to tell people, hey,\Nwe make good widgets.
Dialogue: 0,0:05:50.49,0:05:52.24,Default,,0000,0000,0000,,So none of that is\Nfactored in here.
Dialogue: 0,0:05:52.24,0:05:53.68,Default,,0000,0000,0000,,So that goes into\Nthe next line.
Dialogue: 0,0:05:53.68,0:05:58.41,Default,,0000,0000,0000,,And oftentimes, you'll see it\Nbroken up, where they'll have
Dialogue: 0,0:05:58.41,0:05:59.66,Default,,0000,0000,0000,,marketing expense.
Dialogue: 0,0:06:03.26,0:06:07.20,Default,,0000,0000,0000,,Sometimes you have to pay\Nsalespeople, so you might have
Dialogue: 0,0:06:07.20,0:06:12.38,Default,,0000,0000,0000,,sales expense, and then the\Nstuff like the corporate
Dialogue: 0,0:06:12.38,0:06:15.50,Default,,0000,0000,0000,,office and the CEO's salary, and\Nyou have to hire auditors
Dialogue: 0,0:06:15.50,0:06:17.05,Default,,0000,0000,0000,,and accountants and\Nall of that.
Dialogue: 0,0:06:17.05,0:06:19.13,Default,,0000,0000,0000,,That might be included\Nas general.
Dialogue: 0,0:06:19.13,0:06:20.77,Default,,0000,0000,0000,,Actually, I should be doing this\Nin magenta because it's
Dialogue: 0,0:06:20.77,0:06:22.30,Default,,0000,0000,0000,,all expenses.
Dialogue: 0,0:06:22.30,0:06:25.90,Default,,0000,0000,0000,,Marketing, sales, and then\NG&A you'll sometimes see.
Dialogue: 0,0:06:25.90,0:06:26.79,Default,,0000,0000,0000,,Sometimes you'll see SG&A.
Dialogue: 0,0:06:26.79,0:06:30.92,Default,,0000,0000,0000,,G&A just stands for general and\Nadministrative expenses.
Dialogue: 0,0:06:30.92,0:06:33.45,Default,,0000,0000,0000,,If you see SG&A-- sometimes\Ninstead of that you'll see
Dialogue: 0,0:06:33.45,0:06:37.42,Default,,0000,0000,0000,,SG&A-- that mean selling,\Ngeneral and
Dialogue: 0,0:06:37.42,0:06:38.58,Default,,0000,0000,0000,,administrative expenses.
Dialogue: 0,0:06:38.58,0:06:41.92,Default,,0000,0000,0000,,Selling is things like, it could\Nbe the commissions that
Dialogue: 0,0:06:41.92,0:06:43.07,Default,,0000,0000,0000,,the salespeople get.
Dialogue: 0,0:06:43.07,0:06:45.83,Default,,0000,0000,0000,,It could be just the cost of\Nhaving salespeople travel
Dialogue: 0,0:06:45.83,0:06:49.06,Default,,0000,0000,0000,,around the country and taking\Npeople out to steak dinners.
Dialogue: 0,0:06:49.06,0:06:51.33,Default,,0000,0000,0000,,And then the general and\Nadministrative, that's just
Dialogue: 0,0:06:51.33,0:06:53.27,Default,,0000,0000,0000,,all the stuff that the corporate\Noffice does, and all
Dialogue: 0,0:06:53.27,0:06:55.11,Default,,0000,0000,0000,,the people who are\Nat that level.
Dialogue: 0,0:06:55.11,0:06:57.38,Default,,0000,0000,0000,,So if you subtract these, and\NI'm just making up these
Dialogue: 0,0:06:57.38,0:07:00.12,Default,,0000,0000,0000,,numbers as I go.
Dialogue: 0,0:07:00.12,0:07:05.22,Default,,0000,0000,0000,,Say, in marketing, the company\Nis spending $500,000.
Dialogue: 0,0:07:05.22,0:07:07.28,Default,,0000,0000,0000,,And I'm putting it as a minus\Nbecause I like to remember
Dialogue: 0,0:07:07.28,0:07:08.16,Default,,0000,0000,0000,,it's an expense.
Dialogue: 0,0:07:08.16,0:07:10.18,Default,,0000,0000,0000,,Some models you'll\Nsee, they'll say
Dialogue: 0,0:07:10.18,0:07:12.34,Default,,0000,0000,0000,,it's $500,000 expense.
Dialogue: 0,0:07:12.34,0:07:15.87,Default,,0000,0000,0000,,Sales, let's say, this\Nis just G&A here.
Dialogue: 0,0:07:15.87,0:07:18.13,Default,,0000,0000,0000,,I want to make a separate\Nline for sales.
Dialogue: 0,0:07:18.13,0:07:24.84,Default,,0000,0000,0000,,So let's say sales, selling\Nexpenses is $200,000.
Dialogue: 0,0:07:24.84,0:07:27.40,Default,,0000,0000,0000,,And let's say G&A, the corporate\Noffices and all of
Dialogue: 0,0:07:27.40,0:07:33.84,Default,,0000,0000,0000,,that, let's see that's\Nanother $300,000.
Dialogue: 0,0:07:33.84,0:07:37.21,Default,,0000,0000,0000,,And now we're ready to figure\Nout how much money did the
Dialogue: 0,0:07:37.21,0:07:39.61,Default,,0000,0000,0000,,operations of this\Nbusiness make?
Dialogue: 0,0:07:39.61,0:07:41.26,Default,,0000,0000,0000,,So this is operating profit.
Dialogue: 0,0:07:45.25,0:07:47.50,Default,,0000,0000,0000,,This is really important to pay\Nattention to, because so
Dialogue: 0,0:07:47.50,0:07:49.41,Default,,0000,0000,0000,,many people say, oh, a company\Nmade this much.
Dialogue: 0,0:07:49.41,0:07:51.94,Default,,0000,0000,0000,,And you'll hear these numbers,\Ngross and operating profit and
Dialogue: 0,0:07:51.94,0:07:55.57,Default,,0000,0000,0000,,net profit and pretax profit,\Nand it's very hard to
Dialogue: 0,0:07:55.57,0:07:57.89,Default,,0000,0000,0000,,understand that these are\Nactually very, very different
Dialogue: 0,0:07:57.89,0:08:00.59,Default,,0000,0000,0000,,things, because they all have\Nthe word "profit," and what
Dialogue: 0,0:08:00.59,0:08:02.25,Default,,0000,0000,0000,,does gross and operating\Nand all that mean?
Dialogue: 0,0:08:02.25,0:08:04.30,Default,,0000,0000,0000,,But here you see it means very,\Nvery different things.
Dialogue: 0,0:08:04.30,0:08:06.90,Default,,0000,0000,0000,,Let's calculate this number\Nfirst before I go off on one
Dialogue: 0,0:08:06.90,0:08:09.11,Default,,0000,0000,0000,,of my tangents on all the\Ndifferences between the
Dialogue: 0,0:08:09.11,0:08:10.46,Default,,0000,0000,0000,,operating and the\Ngross profit.
Dialogue: 0,0:08:10.46,0:08:14.45,Default,,0000,0000,0000,,But let's see, 2 million\Nminus 1 million.
Dialogue: 0,0:08:14.45,0:08:15.92,Default,,0000,0000,0000,,My head I think implicitly\Nmade the
Dialogue: 0,0:08:15.92,0:08:16.94,Default,,0000,0000,0000,,numbers work out nicely.
Dialogue: 0,0:08:16.94,0:08:23.03,Default,,0000,0000,0000,,So my operating profit\Nhere is $1 million.
Dialogue: 0,0:08:23.03,0:08:25.83,Default,,0000,0000,0000,,So already we have some\Nnew nuance on profit.
Dialogue: 0,0:08:25.83,0:08:30.15,Default,,0000,0000,0000,,I made $2 million just from\Nactual widget sales, but then
Dialogue: 0,0:08:30.15,0:08:32.52,Default,,0000,0000,0000,,when you take out all of the\Noverhead of the company, the
Dialogue: 0,0:08:32.52,0:08:35.21,Default,,0000,0000,0000,,marketing, the sales, the\Ngeneral and administrative
Dialogue: 0,0:08:35.21,0:08:38.03,Default,,0000,0000,0000,,expenses, I'm only left\Nwith $1 million.
Dialogue: 0,0:08:38.03,0:08:41.61,Default,,0000,0000,0000,,And this is the profit from the\Noperations of the company,
Dialogue: 0,0:08:41.61,0:08:44.39,Default,,0000,0000,0000,,or you could say from the assets\Nor from the business or
Dialogue: 0,0:08:44.39,0:08:45.92,Default,,0000,0000,0000,,from the enterprise\Nof the company.
Dialogue: 0,0:08:45.92,0:08:47.50,Default,,0000,0000,0000,,That's what it is generating.
Dialogue: 0,0:08:47.50,0:08:49.89,Default,,0000,0000,0000,,But we can see-- I've drawn a\Nbunch of balance sheets before
Dialogue: 0,0:08:49.89,0:08:54.41,Default,,0000,0000,0000,,and I think this is a good time\Nto draw a balance sheet.
Dialogue: 0,0:08:54.41,0:08:58.39,Default,,0000,0000,0000,,So you have kind of the\Nassets of a company.
Dialogue: 0,0:08:58.39,0:09:00.57,Default,,0000,0000,0000,,And we'll talk a little bit\Nmore about assets and
Dialogue: 0,0:09:00.57,0:09:03.46,Default,,0000,0000,0000,,enterprise value, and there's\Na little bit of a nuance
Dialogue: 0,0:09:03.46,0:09:05.80,Default,,0000,0000,0000,,there, but essentially\Nthe company itself.
Dialogue: 0,0:09:05.80,0:09:08.42,Default,,0000,0000,0000,,Before you think about how the\Ncompany is paid for or how
Dialogue: 0,0:09:08.42,0:09:11.42,Default,,0000,0000,0000,,it's funded, if you just think\Nabout the enterprise itself,
Dialogue: 0,0:09:11.42,0:09:13.45,Default,,0000,0000,0000,,the assets.
Dialogue: 0,0:09:13.45,0:09:16.98,Default,,0000,0000,0000,,The assets are generating\Nthis.
Dialogue: 0,0:09:16.98,0:09:19.66,Default,,0000,0000,0000,,They're generating the operating\Nprofit, and that's a
Dialogue: 0,0:09:19.66,0:09:22.40,Default,,0000,0000,0000,,very important thing to realize\Nin the future when we
Dialogue: 0,0:09:22.40,0:09:23.59,Default,,0000,0000,0000,,talk about return on assets.
Dialogue: 0,0:09:23.59,0:09:25.36,Default,,0000,0000,0000,,Actually, we could talk\Nabout it now.
Dialogue: 0,0:09:25.36,0:09:31.07,Default,,0000,0000,0000,,Let's say our assets, if we\Npaid $10 million for these
Dialogue: 0,0:09:31.07,0:09:34.65,Default,,0000,0000,0000,,assets, and these assets-- this\Nis the income statement
Dialogue: 0,0:09:34.65,0:09:38.41,Default,,0000,0000,0000,,for 2008-- are spitting out $1\Nmillion a year, or at least $1
Dialogue: 0,0:09:38.41,0:09:41.39,Default,,0000,0000,0000,,million in this year, our return\Non asset-- I wasn't
Dialogue: 0,0:09:41.39,0:09:42.85,Default,,0000,0000,0000,,planning on introducing this,\Nbut it doesn't hurt to
Dialogue: 0,0:09:42.85,0:09:47.45,Default,,0000,0000,0000,,introduce it right now-- our\Nreturn on asset, often
Dialogue: 0,0:09:47.45,0:09:53.53,Default,,0000,0000,0000,,acronymed ROA, would be-- well,\Nthe numerator is the
Dialogue: 0,0:09:53.53,0:09:57.48,Default,,0000,0000,0000,,return, which is $1 million.
Dialogue: 0,0:09:57.48,0:10:01.24,Default,,0000,0000,0000,,The denominator is the\Nassets, $10 million.
Dialogue: 0,0:10:01.24,0:10:04.66,Default,,0000,0000,0000,,So we got a 10% return\Non our assets.
Dialogue: 0,0:10:04.66,0:10:06.24,Default,,0000,0000,0000,,For a $10 million investment,\Nwe're getting
Dialogue: 0,0:10:06.24,0:10:07.09,Default,,0000,0000,0000,,$1 million a year.
Dialogue: 0,0:10:07.09,0:10:11.58,Default,,0000,0000,0000,,We're getting 10% of our asset\Ninvestment back every year.
Dialogue: 0,0:10:11.58,0:10:13.58,Default,,0000,0000,0000,,So that's a nice thing to keep\Nin the back of your mind, this
Dialogue: 0,0:10:13.58,0:10:17.86,Default,,0000,0000,0000,,return on asset concept, and\Nit's very closely tied to
Dialogue: 0,0:10:17.86,0:10:22.17,Default,,0000,0000,0000,,operating profits and the\Nactual assets of a firm.
Dialogue: 0,0:10:22.17,0:10:23.97,Default,,0000,0000,0000,,What we've learned, and\Nespecially if you watched some
Dialogue: 0,0:10:23.97,0:10:26.88,Default,,0000,0000,0000,,of my other economics videos,\Nthat all companies aren't
Dialogue: 0,0:10:26.88,0:10:28.43,Default,,0000,0000,0000,,financed the same.
Dialogue: 0,0:10:28.43,0:10:30.04,Default,,0000,0000,0000,,A lot of them might\Nhave some debt.
Dialogue: 0,0:10:30.04,0:10:33.67,Default,,0000,0000,0000,,So let's say that company had\N$10 million of assets, but
Dialogue: 0,0:10:33.67,0:10:37.38,Default,,0000,0000,0000,,let's say they paid for it\Nwith $5 million of debt.
Dialogue: 0,0:10:40.50,0:10:45.37,Default,,0000,0000,0000,,And let's say the interest rate\Non that debt is-- let me
Dialogue: 0,0:10:45.37,0:10:50.60,Default,,0000,0000,0000,,think of a good number-- 5%.
Dialogue: 0,0:10:57.67,0:10:58.19,Default,,0000,0000,0000,,Let's make it easier.
Dialogue: 0,0:10:58.19,0:11:00.72,Default,,0000,0000,0000,,Let's make it 10% interest.
Dialogue: 0,0:11:00.72,0:11:02.24,Default,,0000,0000,0000,,So this is the operating\Nprofit.
Dialogue: 0,0:11:02.24,0:11:04.79,Default,,0000,0000,0000,,This is the money that just\Ncomes out of the asset itself.
Dialogue: 0,0:11:04.79,0:11:06.98,Default,,0000,0000,0000,,But, of course, that's not the\Nmoney that we get to take
Dialogue: 0,0:11:06.98,0:11:09.09,Default,,0000,0000,0000,,home, because we have to pay\Nthis interest. So let's throw
Dialogue: 0,0:11:09.09,0:11:10.34,Default,,0000,0000,0000,,that in there as an expense.
Dialogue: 0,0:11:13.48,0:11:14.32,Default,,0000,0000,0000,,Interest expense.
Dialogue: 0,0:11:14.32,0:11:16.35,Default,,0000,0000,0000,,And obviously, a company that\Nhas no debt will have no
Dialogue: 0,0:11:16.35,0:11:18.54,Default,,0000,0000,0000,,interest expense, but\Nin this case, we do.
Dialogue: 0,0:11:18.54,0:11:21.35,Default,,0000,0000,0000,,And this is an annual\Nincome statement.
Dialogue: 0,0:11:21.35,0:11:24.99,Default,,0000,0000,0000,,So let's see, if we have $5\Nmillion of debt, and we're
Dialogue: 0,0:11:24.99,0:11:30.24,Default,,0000,0000,0000,,paying 10% on that, 10% of $5\Nmillion is $500,000 a year in
Dialogue: 0,0:11:30.24,0:11:33.97,Default,,0000,0000,0000,,interest. So we have to\Nessentially take half of our
Dialogue: 0,0:11:33.97,0:11:38.66,Default,,0000,0000,0000,,operating profit and give\Nit back to the bank.
Dialogue: 0,0:11:38.66,0:11:43.15,Default,,0000,0000,0000,,And now we are left with our--\Nwe're getting close to where
Dialogue: 0,0:11:43.15,0:11:46.65,Default,,0000,0000,0000,,we need to get to--\Npre-tax income.
Dialogue: 0,0:11:51.37,0:11:58.06,Default,,0000,0000,0000,,And if we do the subtraction,\Nwe're at $500,000.
Dialogue: 0,0:11:58.06,0:11:59.95,Default,,0000,0000,0000,,And you could guess what the\Nnext line is going to be,
Dialogue: 0,0:11:59.95,0:12:01.29,Default,,0000,0000,0000,,given that this says pre-tax.
Dialogue: 0,0:12:01.29,0:12:04.77,Default,,0000,0000,0000,,This is what the owners of the\Ncompany get before they pay
Dialogue: 0,0:12:04.77,0:12:06.51,Default,,0000,0000,0000,,the government.
Dialogue: 0,0:12:06.51,0:12:07.88,Default,,0000,0000,0000,,So you can guess what\Nthe next line is.
Dialogue: 0,0:12:07.88,0:12:09.12,Default,,0000,0000,0000,,It's going to be taxes.
Dialogue: 0,0:12:11.50,0:12:15.76,Default,,0000,0000,0000,,Let's say that it's a 30%\Ncorporate tax rate, and you're
Dialogue: 0,0:12:15.76,0:12:19.02,Default,,0000,0000,0000,,going to take 30% of this\Nnumber right here.
Dialogue: 0,0:12:19.02,0:12:20.52,Default,,0000,0000,0000,,30% of that number\Nright there.
Dialogue: 0,0:12:20.52,0:12:28.58,Default,,0000,0000,0000,,So 30% of $500,000\Nis $150,000.
Dialogue: 0,0:12:28.58,0:12:30.06,Default,,0000,0000,0000,,And then we are done.
Dialogue: 0,0:12:30.06,0:12:33.02,Default,,0000,0000,0000,,We finally have paid off\Neverybody we need to pay off.
Dialogue: 0,0:12:33.02,0:12:36.06,Default,,0000,0000,0000,,So we started off with\N$3 million up here.
Dialogue: 0,0:12:36.06,0:12:39.50,Default,,0000,0000,0000,,We kept paying a bunch of\Nexpenses, and then now we're
Dialogue: 0,0:12:39.50,0:12:40.65,Default,,0000,0000,0000,,left with what?
Dialogue: 0,0:12:40.65,0:12:48.61,Default,,0000,0000,0000,,This is $350,000\Nof net income.
Dialogue: 0,0:12:51.37,0:12:55.30,Default,,0000,0000,0000,,And this is what goes to the\Nowners of the company.
Dialogue: 0,0:12:55.30,0:12:57.91,Default,,0000,0000,0000,,This net income right here.
Dialogue: 0,0:12:57.91,0:13:01.00,Default,,0000,0000,0000,,So going back to our balance\Nsheet, we had a $10 million
Dialogue: 0,0:13:01.00,0:13:03.54,Default,,0000,0000,0000,,asset, we had $5 million\Nof debt.
Dialogue: 0,0:13:03.54,0:13:06.60,Default,,0000,0000,0000,,We know what's left over\Nis the equity.
Dialogue: 0,0:13:06.60,0:13:09.64,Default,,0000,0000,0000,,So let me do that in\Na vibrant color.
Dialogue: 0,0:13:09.64,0:13:11.12,Default,,0000,0000,0000,,Equity is what's left over.
Dialogue: 0,0:13:11.12,0:13:14.10,Default,,0000,0000,0000,,So let's say this is\Nall book value.
Dialogue: 0,0:13:14.10,0:13:15.88,Default,,0000,0000,0000,,So we have $5 million\Nof equity.
Dialogue: 0,0:13:15.88,0:13:18.43,Default,,0000,0000,0000,,And when I say book value,\Nthat's just a fancy way of
Dialogue: 0,0:13:18.43,0:13:21.81,Default,,0000,0000,0000,,saying this is what our\Naccountants say that we paid
Dialogue: 0,0:13:21.81,0:13:22.83,Default,,0000,0000,0000,,for the stuff.
Dialogue: 0,0:13:22.83,0:13:24.18,Default,,0000,0000,0000,,This is what we have\Non our books.
Dialogue: 0,0:13:24.18,0:13:26.92,Default,,0000,0000,0000,,And we'll talk later about\Ndepreciation and amortization
Dialogue: 0,0:13:26.92,0:13:30.62,Default,,0000,0000,0000,,and how we might change what\Nthese values are, but a very
Dialogue: 0,0:13:30.62,0:13:33.38,Default,,0000,0000,0000,,simple way is, if you went out\Nand bought $10 million worth
Dialogue: 0,0:13:33.38,0:13:34.91,Default,,0000,0000,0000,,of stuff, you'd write on\Nyour books, I have
Dialogue: 0,0:13:34.91,0:13:36.25,Default,,0000,0000,0000,,a $10 million asset.
Dialogue: 0,0:13:36.25,0:13:40.01,Default,,0000,0000,0000,,And if you took a $5 million\Nloan, then what you really
Dialogue: 0,0:13:40.01,0:13:42.26,Default,,0000,0000,0000,,own, if you were to kind of sell\Nall of this, you would
Dialogue: 0,0:13:42.26,0:13:46.96,Default,,0000,0000,0000,,get $5 million of equity.
Dialogue: 0,0:13:46.96,0:13:48.89,Default,,0000,0000,0000,,And I think this is an\Ninteresting thing.
Dialogue: 0,0:13:48.89,0:13:51.63,Default,,0000,0000,0000,,When we did return on asset,\Nwe looked at the operating
Dialogue: 0,0:13:51.63,0:13:55.01,Default,,0000,0000,0000,,profit, because this is what our\Ncompany generated before
Dialogue: 0,0:13:55.01,0:13:57.82,Default,,0000,0000,0000,,we paid the bank or Uncle Sam\Nor anything like that.
Dialogue: 0,0:13:57.82,0:14:01.34,Default,,0000,0000,0000,,And so we took this number as\Nthe numerator and we divided
Dialogue: 0,0:14:01.34,0:14:02.84,Default,,0000,0000,0000,,by the number of assets.
Dialogue: 0,0:14:02.84,0:14:06.28,Default,,0000,0000,0000,,Now we can do another notion,\Nand that's return on equity.
Dialogue: 0,0:14:11.63,0:14:14.62,Default,,0000,0000,0000,,In return on equity, the\Nnumerator is the net income
Dialogue: 0,0:14:14.62,0:14:19.46,Default,,0000,0000,0000,,that we got, so it's $350,000.
Dialogue: 0,0:14:19.46,0:14:23.12,Default,,0000,0000,0000,,And the denominator here is the\Nequity, the book value of
Dialogue: 0,0:14:23.12,0:14:26.04,Default,,0000,0000,0000,,our equity, so that's\N$5 million.
Dialogue: 0,0:14:26.04,0:14:27.30,Default,,0000,0000,0000,,One, two, three.
Dialogue: 0,0:14:27.30,0:14:28.20,Default,,0000,0000,0000,,One, two, three.
Dialogue: 0,0:14:28.20,0:14:30.25,Default,,0000,0000,0000,,Let's cancel some zeroes out.
Dialogue: 0,0:14:30.25,0:14:33.38,Default,,0000,0000,0000,,So it's like 35/500.
Dialogue: 0,0:14:33.38,0:14:38.23,Default,,0000,0000,0000,,35/500 is the same thing\Nis 7/100, so it equals
Dialogue: 0,0:14:38.23,0:14:42.46,Default,,0000,0000,0000,,7% return on equity.
Dialogue: 0,0:14:42.46,0:14:44.65,Default,,0000,0000,0000,,And that's interesting because,\Nwell, why that's
Dialogue: 0,0:14:44.65,0:14:48.78,Default,,0000,0000,0000,,lower is-- well, I don't want\Nto go into too much depth
Dialogue: 0,0:14:48.78,0:14:51.33,Default,,0000,0000,0000,,because I realize I'm already\Npushing my time limit.
Dialogue: 0,0:14:51.33,0:14:53.73,Default,,0000,0000,0000,,But at this point, you should\Nhave a good understanding of
Dialogue: 0,0:14:53.73,0:14:57.72,Default,,0000,0000,0000,,at least a basic income\Nstatement of a company that
Dialogue: 0,0:14:57.72,0:14:58.42,Default,,0000,0000,0000,,sells widgets.
Dialogue: 0,0:14:58.42,0:15:00.01,Default,,0000,0000,0000,,And in the future, we're gonna\Nlook at a lot of different
Dialogue: 0,0:15:00.01,0:15:01.83,Default,,0000,0000,0000,,companies, financial companies,\Ninsurance
Dialogue: 0,0:15:01.83,0:15:05.65,Default,,0000,0000,0000,,companies, natural gas pipeline\Ncompanies, that will
Dialogue: 0,0:15:05.65,0:15:08.10,Default,,0000,0000,0000,,have very different-looking\Nincome statements, but this
Dialogue: 0,0:15:08.10,0:15:10.21,Default,,0000,0000,0000,,gives you the general template\Nfor how things work.
Dialogue: 0,0:15:10.21,0:15:13.92,Default,,0000,0000,0000,,And at least it'll give you a\Nsense of how revenues, gross
Dialogue: 0,0:15:13.92,0:15:17.30,Default,,0000,0000,0000,,profit, operating profit,\Npre-tax income and net income
Dialogue: 0,0:15:17.30,0:15:18.57,Default,,0000,0000,0000,,really are different.
Dialogue: 0,0:15:18.57,0:15:19.96,Default,,0000,0000,0000,,A lot of times in the\Npopular press.
Dialogue: 0,0:15:19.96,0:15:22.94,Default,,0000,0000,0000,,They're all jumbled up as just\Nkind of the company is making
Dialogue: 0,0:15:22.94,0:15:23.93,Default,,0000,0000,0000,,this much money.
Dialogue: 0,0:15:23.93,0:15:26.49,Default,,0000,0000,0000,,Anyway, I'll see you\Nin the next video.